2018 (4) TMI 1979 - AT - Income Tax

Disallowance of warranty provision - assessee could not explain to scientific basis on which the warranty provision was paid - assessee explained that the assessee gives post sales warranty against the performance of its product and manufacturing defects therein and this can be observed in the terms of delivery and payment mentioned in the sample copies of the order confirmation document - HELD THAT - This provision for warranty is estimated by the assessee on scientific basis and assessee has claimed net of provision utilized during the year as per reversal method of accounting and hence we find no infirmity in the claim of the assessee. Accordingly, we reverse the orders of the lower authorities and allow the claim of the assessee. This issue of assessee s appeal is allowed. Nature of gain - Gain arising on land building as a separate long term capital gain and short term capital gain - HELD THAT - We find that the CIT(A) has rightly treated the sale consideration arising out of land as long term capital gain and sale consideration attributable to building as short term capital gain. Hence, we find no infirmity in the order of CIT(A) and hence the same is confirmed. The issue of Revenue s appeal is dismissed.

Summary

Issues Involved:
1. Deletion of disallowance of warranty provisions.
2. Treatment of gain arising from the sale of land and building as separate long-term and short-term capital gains.

Issue-wise Detailed Analysis:

1. Deletion of Disallowance of Warranty Provisions:
The first issue pertains to the CIT(A)'s decision to delete the disallowance of the warranty provision claimed by the assessee. The Revenue contended that the warranty provision was contingent, made on an estimate basis, and not supported by a reliable estimate based on past experience, thus rendering the Supreme Court decision in Rotork Controls India Pvt. Ltd. inapplicable.

The assessee had debited ?21,10,038 as a provision for warranty, claiming it as a deduction. The AO disallowed this, arguing that the provision was ad hoc and lacked a scientific basis. The CIT(A) admitted additional evidence and concluded that the warranty was embedded in the sale price, creating an ascertained liability upon sale. The CIT(A) found that the provision was created on a reasonable basis and reversed when the liability crystallized, satisfying the conditions laid down by the Supreme Court in Rotork Controls India Pvt. Ltd. Consequently, the CIT(A) directed the AO to allow the claim.

Upon appeal, the Revenue argued that the assessee failed to explain the scientific basis for the warranty provision. The assessee countered that the warranty was a contractual obligation included in the sales price, thus constituting an ascertained liability. The provision was based on past experience and calculated as a specific percentage of sales.

The Tribunal reviewed the facts, noting that the provision for warranty was consistent with previous years and had not been disallowed in earlier assessments. The Tribunal referred to the Supreme Court's decision in Rotork Controls India Pvt. Ltd., which emphasized that the provision for warranty should be based on historical trends and a robust accounting system. The Tribunal concluded that the provision was estimated on a scientific basis and allowed the claim, reversing the lower authorities' orders.

2. Treatment of Gain Arising from Sale of Land and Building:
The second issue involves the CIT(A)'s direction to treat the gain from the sale of land and building separately as long-term and short-term capital gains. The Revenue argued that the land and buildings were sold as a package through a transfer deed, and thus, the entire gain should be treated as short-term capital gain under section 50(1) of the Act.

The assessee sold its factory building and land for ?5,75,00,000 and declared a long-term capital gain on the sale. The AO treated the entire gain as short-term capital gain, considering the property as a depreciable asset. The CIT(A) assessed the sale proceeds of the land as long-term capital gain and the building as short-term capital gain, directing the AO to ascertain the difference between the actual cost and the written-down value of the depreciable assets.

The Tribunal reviewed the facts and upheld the CIT(A)'s decision to treat the sale consideration for land as long-term capital gain and the building as short-term capital gain. The Tribunal found no infirmity in the CIT(A)'s order and dismissed the Revenue's appeal on this issue.

Assessee's Appeal on WDV of Building:
The assessee also appealed against the CIT(A)'s direction to consider the WDV of the building as per the Companies Act instead of the Income Tax Act. However, the assessee's counsel stated that the CIT(A) had already passed a rectification order, and thus, the assessee was not interested in prosecuting this ground. Consequently, this ground was dismissed as not pressed.

Conclusion:
The appeal of the assessee was partly allowed, and the appeal of the Revenue was dismissed. The order was pronounced in the open court on 11-04-2018.